Hong Kong has no delisting rules – but retail investors seem to like it that way

Officials worry that lack of a mechanism has led some companies to let their performance slip, both financially and in maintaining their share prices

PUBLISHED : Friday, 07 October, 2016, 4:03pm
UPDATED : Friday, 07 October, 2016, 10:26pm

Hong Kong is the world’s biggest market for initial public offerings, but it may rank bottom in terms of the number of companies that have been delisted.

Unlike New York, London and Tokyo, and even the mainland, the local bourse does not have a mechanism in place to forcibly expel poorly performing listed companies.

Delistings can be for any number of reasons, but mostly they involve the failure to meet an exchange’s minimum requirements for price, capitalisation or liquidity. In extreme cases, they are linked to fraud or failure to file reports the exchange or regulators require.

Shenzhen Stock Exchange has already noted the lack of a delisting mechanism as a key risk factor to be considered by mainland investors seeking to invest in Hong Kong.

Even many penny stocks or companies suffering serious losses have never been expelled from Hong Kong Exchanges and Clearing.

Benny Mau, chairman of Hong Kong Securities Association, says the lack of a delisting mechanism has led some companies to let their performances slip, both financially and in maintaining their share prices.

As long as you pay your listing fee on time and the business remains in operation, then you do not need to worry about delisting. This is why so many companies perform badly in the immediate aftermath of a listing
Benny Mau, chairman , Hong Kong Securities Association

“Hong Kong requires a [listing] hopeful to show at least a HK$50 million profit in the three years leading up to a listing. However, there are no profit or share price requirements after a company has listed which means all companies can effectively start to lose money and not worry about being expelled from the stock market.

“As long as you pay your listing fee on time and the business remains in operation, then you do not need to worry about delisting,” Mau said.

“This is why so many companies perform badly in the immediate aftermath of a listing.”

The Shenzhen and Shanghai stock exchanges will both expel companies that post three years of losses in a row, with their shares demoted to the over-the-counter market, the so-called Third Board.

The Nasdaq in the United States delists any company trading below US$1 for 30 days. In Taiwan, they can be removed from the exchange if the market capitalisation falls below NT$200 million (HK$49 million).

The Nasdaq releases the number of companies to be delisted on its website every Thursday. Currently, 27 firms will be removed over the next 10 days.

That is nearly three times the 11 companies delisted from Hong Kong in the first nine months of this year, and those include four firms moved from the Growth Enterprise Market to the main board, and two via privatisations.

The lack of a forced delisting mechanism means companies that make losses for many years, trading at low prices, with little market cap, can survive on the Hong Kong market indefinitely.

The only reasons so-called penny stocks can be forced to delist, are if they fall into financial trouble, when they can be suspended for two years, or fail to match public float or other compliance requirements.

But even then, if a white knight can be found to buy shares in the company or inject new assets, then they can resume trading.

In July 2002, Hong Kong attempted to introduce rules to delist companies trading below 50 HK cents for a full month. The next day, HK$10 billion worth of value was lost, as investors rushed to dump penny stocks.

Embarrassingly, the stock exchange scrapped the consultation exercise four days later. The fiasco left many casualties, not just the retail investors who lost money.

The then-secretary for financial services and the treasury, Frederick Ma Si-hang, publicly apologised, while HKEX chief executive Kwong Ki-chi lost his HK$7.95 million a year job after resigning for “personal reasons”.

In November 2002, HKEX relaunched the delisting consultation paper which removed the 50 HK cent delisting threshold, but proposed other methods such as market caps or profitability levels to determine if a firm should be dropped.

The consultation took three years. The final decision was that nothing would be done, after majority opposition to the idea.

“Respondents suggested that low-priced securities are a feature of every market, a result of market forces of supply and demand and do not bear any relationship to the fairness or good order of the market,” a HKEX paper said then.

Mau said although a delisting mechanism would help improve corporate governance, he believes the exchange would not seriously consider reintroducing the proposal after the penny stock fiasco.

There are several hundred penny stocks in Hong Kong, which are often popular with retail investors. They would potentially gains billions of dollars, for instance, if they allowed companies to be used as “shells” to allow back-door listings.

There is such a long history of retail investors trading penny stocks in Hong Kong that I don’t see how that can be quickly stopped
Ken Wong, Asia equity portfolio specialist, Eastspring Investments

But in the first instance, they are seen as a short cut towards a formal application.

Buyers, however, need to pay a premium of

HK$400 million to HK$600 million to the company’s original shareholders to buy the listing status.

Ken Wong, Asia equity portfolio specialist at Eastspring Investments, shares the view it would be difficult for HKEX to delist shares trading under 50 HK cents, as penny stocks have been a feature of the Hong Kong market for decades.

“There is such a long history of retail investors trading penny stocks in Hong Kong that I don’t see how that can be quickly stopped,” Wong said.

However, Brett McGonegal, the chief executive of Capital Link International, said all markets need clearly defined delisting rules.

“The reasons for a delisting certainly start with the need and desire to protect investors from buying into troubled companies,” McGonegal said.

“The exchange has a silent implication of corporate and financial stability and it’s the exchange’s job to continually police these issues,” he said.

“On another level, illiquid troubled companies sometimes have trading characteristics that lend themselves to manipulation by operators which needs to be controlled.

”A minimum stock price is not the right governance mechanism as there are plenty of ways around it via reverse splits. The controls should focus on market cap, revenue, profit tests and there should be a warning and grace period for the companies, to regain compliance,” McGonegal said.

Gordon Tsui Luen-on, the managing director of Hantec Group International Finance, said the HKEX could introduce a delisting mechanism if and when it launches its own planned third board for start-ups.

“The HKEX might decide to introduce a third board and this would be the right timing to introduce a delisting mechanism, on a pilot basis,” Tsui said.

Elvin Yu, the principal at pension consultancy firm Goji Consulting, said that pension fund managers invest for the long term, in companies with stable dividends.

“It is, therefore, very unlikely they would invest in any listed company that makes consecutive years of financial losses,” he said.

“Poor performing companies could be turned around with a change in management or other factors, so the key is how much tolerance there should be, before a warning is triggered, and delisting imposed.”